August 19, 2010

Confusion Reigns at TNR on the Stimulus … For Good Reason

This month, various contributors to TNR have argued about economic stimulus: It works, it doesn’t work, or we don’t know if it works or not. On August 17, Josef Joffe asserted (with caveats) on Entanglements that we know stimulus doesn’t work because (1) economic trendlines in the United States have not improved dramatically since it was instituted here, and (2) those countries that have spent a lot on stimulus don’t seem to be doing as well as some countries that have not. In a fairly jocular way, Joffe criticized his own analysis by saying, “[I]t is silly to draw so much conclusion from so little evidence,” but he nonetheless argues that “the prima facie evidence is pretty compelling” that “stimulus spending doesn’t work.” (Presumably, Joffe believes that he is providing useful evidence that demonstrates this—or else what is the point of the post?) Six days earlier, Kenan Fikri and Mark Muro reminded us on The Avenue that:

In November 2009 we and the National League of Cities (and many others) warned that steep state and local public sector cuts loomed on the horizon, and that these cuts could undermine any nascent economic recovery just as the federal government’s unprecedented stimulus spending wound down.

Fikri and Muro clearly believe this kind of spending has a stimulative multiplier effect beyond the specific jobs that would be cut:

How is it that the local government fiscal crisis threatens the entire economy’s recovery? Essentially because every local or state cut acts as a stroke of “anti-stimulus” by reducing demand.

Two days before Fikri and Muro’s post, Jon Chait argued that we can’t measure whether the stimulus had an impact or not:

The truth is that you can't prove whether the stimulus worked or not. You can try to reconstruct the effects of the stimulus (and other government interventions) as Alan Blinder and Mark Zandi did. But you're still making assumptions on the basis of economic models--mainstream assumptions shared by most economists, but assumptions nonetheless. Actually proving the case would require going back to 2009 and re-running history with everything the same but no stimulus. Since we can't do that, all we can do is guess.

So who in this debate, if anybody, is right?

Chait is right. The reason we don’t know whether the stimulus has worked in the United States is fundamental. And I believe it has significant implications for how we should approach public policy in the recession. Here is what I wrote in a recent article in the policy quarterly City Journal:

In early 2009, the United States was engaged in an intense public debate over a proposed $800 billion stimulus bill designed to boost economic activity through government borrowing and spending. James Buchanan, Edward Prescott, Vernon Smith, and Gary Becker, all Nobel laureates in economics, argued that while the stimulus might be an important emergency measure, it would fail to improve economic performance. Nobel laureates Paul Krugman and Joseph Stiglitz, on the other hand, argued that the stimulus would improve the economy and indeed that it should be bigger. Fierce debates can be found in frontier areas of all the sciences, of course, but this was as if, on the night before the Apollo moon launch, half of the world’s Nobel laureates in physics were asserting that rockets couldn’t reach the moon and the other half were saying that they could. Prior to the launch of the stimulus program, the only thing that anyone could conclude with high confidence was that several Nobelists would be wrong about it.

But the situation was even worse: it was clear that we wouldn’t know which economists were right even after the fact. Suppose that on February 1, 2009, Famous Economist X had predicted: “In two years, unemployment will be about 8 percent if we pass the stimulus bill, but about 10 percent if we don’t.” What do you think would happen when 2011 rolled around and unemployment was still at 10 percent, despite the passage of the bill? It’s a safe bet that Professor X would say something like: “Yes, but other conditions deteriorated faster than anticipated, so if we hadn’t passed the stimulus bill, unemployment would have been more like 12 percent. So I was right: the bill reduced unemployment by about 2 percent.”

Another way of putting the problem is that we have no reliable way to measure counterfactuals—that is, to know what would have happened had we not executed some policy—because so many other factors influence the outcome. This seemingly narrow problem is central to our continuing inability to transform social sciences into actual sciences. Unlike physics or biology, the social sciences have not demonstrated the capacity to produce a substantial body of useful, nonobvious, and reliable predictive rules about what they study—that is, human social behavior, including the impact of proposed government programs.

Amusingly, and as if on cue, the Wall Street Journal had an article on July 29 about the stimulus debate. The article opened:

Eighteen months after President Barack Obama administered a massive dose of spending increases and tax cuts to a weak economy, a brawl has broken out among economists and politicians about whether fiscal-stimulus medicine is curing the illness or making it worse.

…

But today, neither side can say with certainty whether the latest stimulus worked, because nobody knows what would have happened in its absence.

…

The Obama administration is stocked with heirs of Mr. Keynes, including academics Christina Romer and Mr. Summers. Ms. Romer famously projected in January 2009 that without government support, the unemployment rate would reach 9%, but with support the government could keep it under 8%. It’s 9.5% today.

Some Obama administration officials privately acknowledge they set job-creation expectations too high. The economy, they argue, was in fact sicker in 2009 than they and most others realized at the time. But they insist unemployment would have been worse without the stimulus.

Why does this matter? Because our inability to establish this causal relationship is inherent to the problem. There is no correct answer out there that we can access if we just listen to the people who “know what they’re talking about.”

I believe that recognition of our ignorance should lead us to two important, though tentative and imprecise, conclusions.

First, we should treat anybody who states definitively that the result of stimulus policy X will be economic outcome Y with extreme skepticism. And weaseling about the magnitude of the predicted impact such that all outcomes within the purported range of uncertainty still magically lead to the same policy conclusion doesn’t count; we should recognize that we don’t even know at the most basic level whether stimulus works or not.

Second, “boldness” in the face of ignorance should not be seen in heroic terms. It is a desperate move taken only when other options are exhausted, and with our eyes open to the fact that we are taking a wild risk. Actual science can allow us to act on counterintuitive predictions with confidence--who would think intuitively that it’s a smart idea to get into a heavy metal tube and then go 30,000 feet up into the air? But we don’t have this kind of knowledge about a stimulus policy. We are walking into a casino and putting $800 billion dollars down on a single bet in a game where we don’t even know the rules. In general, in the face of this kind of uncertainty, we ought to seek policy interventions that are as narrowly targeted as is consistent with addressing the problem; tested prior to implementation to whatever extent possible; hedged on multiple dimensions; and designed to be as reversible as is practicable.

What I am trying to describe here is not a policy per se, but an attitude of epistemic humility.